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Kevin Kersten's Analyst Insights

January 13, 2014 - Are metals a solid investment for 2014?

As earnings for 2014 roll in, we get our first look at what the year is likely to produce. There have been some big changes already as Bernanke has been replaced by Janet Yellen leading the Fed Reserve Bank. America's trade deficit has declined to a four-year low as America's need for foreign oil imports is lessened by fracking. The oil booms in Texas and North Dakota should benefit us with reliable energy and we may even become the world's top oil producer in a few years.

The economy is recovering although not as fast as some would like. Some analysts expect GDP growth will come in at 1.7% in 2013 below the 2.2% of 2012 and the 2.8% projected for 2014. The stock market is doing well, setting record highs, but there are reasons to cautious. Just because the stock market is rising, it also pays to look at other metrics to see how the economy is doing.

While oil and GDP numbers can be very useful another metric that is good to look at is raw materials. As we produce more goods, more raw materials are used to create them. New construction, a driver of economic growth uses as a lot of steel wood and other resources. Even more directly than oil, iron and steel are used in everything from new cars to fence posts.

Commercial Metals Company (CMC) recycles and makes iron and steel products. The company sold $6.8 billion in iron last year pulling in profits of $0.64 per share. A steel mini-mill competing with companies like Nucor (NUE), Schnitzer (SCHN) and Steel Dynamics (STLD), it faced a number of big factors affecting the industry over the last few years.

There are several big factors affecting the price of iron. Nonresidential construction is expected to rise 5.1% in 2014, ahead of a 0.2% growth rate in 2013. Automobile production is picking up with 14.4 million cars made in 2012, 15.5 million cars make 2013 and 16 million new cars expected to be sold in 2014. However, while US auto production has picked up this is not the case in Europe which is still facing some difficult economic times. Iron is an international commodity and ships sail iron all over the world on a regular basis. This means slowing construction in China and a lack of new car sales in Europe can affect commodity prices here.

Prices are also affected by supply. As more mills come online, prices for steel can actually fall. In 2012 steel volumes rose 4%, but steel prices fell. The result was that revenues did not gain a whole lot.

Revenues are still down from the 2008 $10.4B peak. In 2013, the company brought in $6.8 billion in revenues while making 0.64 per share. Analysts expect both volumes of steel made as well as steel prices to rise, causing earnings of 1.20 a share in 2014.

In the first quarter, the company reported $0.39 per share which actually had $0.27 per share from continuing operations. Analysts had expected $0.24 per share. The revenues dropped by 8 percent compared to the year prior.

With expanding production recovering economies and rising prices iron may well be looking up, but with stock markets already at historic highs more realistic expectations might be warranted.

As a result one might want to consider the dynamics of a covered call trade. Buying the stock near 20.30 a share and selling the June 20 call for a 1.35 will give you and entry price of 18.95. If the stock expires at 20 you will pull in a 5.5% [(20/18.95)-1] return over the next 163 days. That is a 12.4% annualized return rate (for comparison purposes only). The stock also pays a dividend yield of 2.38%.

Steel production is looking up as commercial building and car production increases. With more production and higher prices the recovery is materializing, but it is still going to take some time. Selling that time by using a covered call can reduce your holding costs of the stock.